Europe: Reborn from its own ashes?
Over the past decade, global investors would have been wise to largely ignore eurozone equities. Their underperformance has not been constant, but intermittent policy-driven rallies have become weaker and shallower. Eurozone stocks outperformed for two years after Mario Draghi’s 2012 promise to do “whatever it takes” to save the euro, yet by the time the European Central Bank got around to launching its asset-buying program in 2015 the benefit quickly faded—within a few months eurozone equities were back to lagging their peers on a scale seen in the 2011-12 crisis (see chart below). This observation is relevant to fears about the market fallout from the Brexit vote as most investors were worried not so much about its impact on Britain (which represents less than 3% of global GDP), but whether a Brexit will mark the beginning of the end for a hobbling European Union?
In recent weeks, financial markets have been at their most myopic, selling off on every poll favouring a Brexit and rallying on each widening in the bookmakers’ odds for a Leave vote. Such behaviour would suggest that the threat to the EU is one-dimensional, which is clearly not the case. After all, Beppe Grillo’s Five Star movement just won municipal elections in Rome and Turin on the back of antieuro sentiment. In Spain, Podemos, a party that did not exist a decade ago has emerged as a backlash against Brussels’ diktat. In a similar vein the Alternative for Germany party has morphed from being an anti-euro force to a squarely antiimmigrant party, while in France, no-one doubts that Marine Le Pen’s National Front will be in the second round of next year’s presidential election — the only question being, who will stand against her?
The reality, of course, is that two decades of “one-size fits all” policies, have not delivered European voters the shining tomorrows they were promised 20 years ago; hence, a growing minority of them feel duped. The question that investors must confront is whether this minority turns into a majority in the near future, not only in Britain, but in countries around Europe.At some point, a movement such as Podemos in Spain or Five Star in Italy does sufficiently energise voters to reject the EU and these political parties will not be bullied or bought off like Syriza was in Greece.
What will be the likely financial market response after the Brexit vote? A panic for a week or two is probable as the decision will be treated as the death-knell for a poorly functioning EU. But, on the flip side, and as Charles Gave often likes to say, was it bad news when the Soviet Union imploded? When something doesn’t work (and ten years of constant European equity underperformance, high unemployment rates, and dissatisfaction among voters shows that something isn’t quite right), why keep going down the same path, pretending that all is well?
Had a Brexit been rejected, then Europe in the short term would at least have been likely to meander along and investors would then be free to fret about the rise of Podemos (which is worrying), or the ascent of the National Front (even more worrying), or the rise of the AfD.
In essence, the question that will be answered in the coming days is whether Europe, like a phoenix, is given the option of being reborn from its own ashes, or if Europe, following a brief upturn in asset markets, returns to its trend of slowly slipping into irrelevance for most global investors.